After the drama of the Fiscal cliff the US economy is set to face a new round of uncertainty in the form of the ‘debt ceiling’. You may have heard the phrase before, as in 2011 the financial markets were in turmoil once again as the US congress argue over whether to raise it, resulting in a financial crisis.
What is the debt ceiling?
The concept of the debt ceiling dates back to 1917 and was originally made to provide more flexibility to finance the USA’s involvement in World War One. Since then, the Treasury may borrow any amount needed as long as it keeps the total at or below the authorized debt ceiling. To change the debt ceiling, Congress must enact specific legislation, and the President must sign it into law.
In May 2011, the modern debt ceiling crisis began. Approximately over 40% of US government spending relied on borrowed money. Without borrowing money the federal government would have had to immediately cut spending by 40%, a situation that would have had devastating impacts on the US and global economy.
Worryingly because of its high borrowing he amount of interest the government must pay is incredibly high. In 2011 the US came close to defaulting on those payments.
Raising the debt limit in effect allows the government to borrow more money without defaulting.
According to the Treasury, “failing to increase the debt limit would cause the government to default on its legal obligations – an unprecedented event in American history”.These legal obligations include paying Social Security and Medicare benefits, military salaries, interest on the debt, and many other items. Making the promised payments of the principal and interest of US treasury securities on time ensures that the nation does not default on its sovereign debt.
In the USA the federal government can pay for expenditures only if it has been approved by Congress in an appropriation bill. This is the problem that faced President Obama in 2011 and will soon rear its head in 2013. The house of congress is comprised mostly of Republicans, opponents of Obama who want to force the President to lower government spending and they are hell bent on getting their way.